5 Key Pillars of Captive Insurer Corporate Governance

Effective corporate governance is essential for any organization, including captive insurers. While numerous articles suggest varying numbers of governance pillars, ranging from three to seven, we believe that five pillars strike the right balance and are widely recognized. However, the precise number is less crucial than the unwavering commitment to uphold these principles. Without transparency and accountability, the specific pillars become irrelevant.

Five key pillars of captive corporate governance are as follows.

• Independence
• Accountability
• Fairness
• Responsibility
• Transparency

While independence is a crucial key pillar of primary focus for captive insurers, all are important for effective corporate governance.

Independence

Captive domicile regulations typically mandate that captive insurers and risk retention groups include at least one independent director on their board. However, defining "true" independence raises several questions. Many state statutes require the independent director to reside within the state. This legislative restriction can be limiting for a few reasons.

Firstly, if a state hosts a large number of captives but has a limited pool of directors, it often results in an independent director serving on multiple boards. This not only demands a significant time commitment but also raises potential conflicts of interest, as directors gain access to sensitive information from various captives. Secondly, it's common for an "independent" director to also hold roles such as general counsel for the captive or as part of the management team. Even though such an individual is not directly related to the entities that formed the captive, their ability to remain truly independent can be compromised when serving in multiple capacities.

The National Association of Corporate Directors (NACD) suggests that an independent director should meet the standards defined by a self-regulatory organization (SRO). According to a composite definition from various US and non-US SROs, an "independent director" is defined as one who has no direct or indirect material relationship with the company, other than their membership on the board.

An independent director plays a crucial role in ensuring that both management and the board adhere to the other four pillars of corporate governance, often by posing challenging questions that others might not.

Accountability

Accountability in corporate governance means taking responsibility for the strategies and tactics necessary to achieve organizational goals. While accountability is often perceived negatively, associating it with assigning blame for failures, it actually involves recognizing both the rewards and the risks tied to reaching the objectives of a captive insurer.

For captive insurers, particularly those that delegate many operational tasks, it's vital to establish clear lines of accountability. This should be defined and agreed upon at the outset of any contract negotiations to clarify who is ultimately responsible for decisions. The saying "success has many fathers, but failure is an orphan" underscores the typical challenges of accountability. Thus, effective corporate governance necessitates a clear understanding and formal acknowledgment of accountability.

Fairness

Fairness involves treating all stakeholders reasonably and equitably. In the context of captive insurers, fairness is a critical consideration in several areas, including claims handling, pricing, and underwriting, and may extend to eligibility for board membership.

Moreover, fairness necessitates providing an effective mechanism for addressing perceived or actual violations. For many captive insurers, resolving disputes may involve arbitration between the captive and a policyholder. A notable concern arises when policyholders are required to undergo arbitration where the captive's board of directors serves as the arbitrator. In such cases, the directors, who may have conflicts of interest due to their dual roles, are not disinterested parties.

Although third-party arbitration might incur higher costs, it offers a more impartial and equitable solution compared to arbitration conducted by the board of directors.

Responsibility

As previously mentioned, accountability involves taking ownership of the strategies and tactics used by a captive insurer, applicable to both managers and board members. Responsibility is closely linked with accountability. Since both managers and board members hold the authority (accountability) to act on behalf of the captive insurer, they must also fully accept the responsibility that comes with exercising these powers.

Responsibility demands a thorough understanding of the proposed actions, including their potential consequences. A responsible director must carefully consider the impact of these actions on all stakeholders of the captive insurer. This often involves making tough decisions that balance fairness and transparency, ensuring that all actions are well informed and considerate of the broader implications for the organization.

Transparency

Transparency has become a fundamental term in corporate governance, exemplified by the disclosure practices such as the availability of a business jet for CEO travel. In its essence, transparency means having nothing to hide.

In the context of a captive insurer, however, the pursuit of transparency is more nuanced. Management and the board must recognize that while transparency generally implies full disclosure, there are situations, such as in claims handling, where complete openness may not be in the best interest of the captive. Therefore, while promoting transparency is important, it must be balanced with accountability and fairness. Good governance requires that boards and management teams deeply understand these principles to make well-informed decisions about the appropriate level of transparency.

Ultimately, every manager and board member should commit to ongoing education and understanding of these governance pillars to improve both their individual performance and that of the captive insurer.